Ch. 21 Demand and Supply Section 1 Demand

An Introduction to Demand In the U.S., the forces of supply and demand work together to set prices In the U.S., the forces of supply and demand work together to set prices Demand – the desire, willingness, and ability to buy a good or service. Demand – the desire, willingness, and ability to buy a good or service. 3 things must be in place if demand is to exist: 3 things must be in place if demand is to exist: 1. Consumer must want a good or service 2. Consumer must be willing to buy it 3. Consumer must have the resources to buy it

Individual Demand Schedule Demand schedule – table that lists the various quantities of a product or service that someone is willing to buy over a range of possible prices Demand schedule – table that lists the various quantities of a product or service that someone is willing to buy over a range of possible prices Can be shown as points on a graph. Can be shown as points on a graph. Prices = vertical axis Prices = vertical axis Quantities = horizontal axis Quantities = horizontal axis Each point shows how many units of a product an individual will buy at a certain price Each point shows how many units of a product an individual will buy at a certain price Demand Curve – the line that connects these points Demand Curve – the line that connects these points

Individual Demand Schedule The demand curve will always slope downward The demand curve will always slope downward This shows that people are less willing to buy at a higher price, and more willing to buy at a lower price. This shows that people are less willing to buy at a higher price, and more willing to buy at a lower price. This principle is known as the law of demand – quantity demanded and price will always move in opposite directions This principle is known as the law of demand – quantity demanded and price will always move in opposite directions Q P Q P

Market Demand Market Demand – the total demand of all consumers for a product or service. Market Demand – the total demand of all consumers for a product or service. Market demand can be shown as a demand schedule (table) and demand curve (graph) Market demand can be shown as a demand schedule (table) and demand curve (graph)

Marginal Utility We buy products for their utility – the pleasure, usefulness, or satisfaction they give us. We buy products for their utility – the pleasure, usefulness, or satisfaction they give us. Utility of a good will be different for different people Utility of a good will be different for different people Some products may have no utility for some people Some products may have no utility for some people Ex. Pizza when you are hungry Ex. Pizza when you are hungry

Marginal Utility (cont.) Diminishing Marginal Utility – states that our additional satisfaction tends to go down as we consume more and more units Diminishing Marginal Utility – states that our additional satisfaction tends to go down as we consume more and more units When we make a purchase, we consider whether the satisfaction we expect to gain is worth the money we must give up. When we make a purchase, we consider whether the satisfaction we expect to gain is worth the money we must give up. If the marginal utility > marginal costs = we make the purchase If the marginal utility > marginal costs = we make the purchase If the marginal utility < marginal costs = we walk away If the marginal utility < marginal costs = we walk away

Marginal Utility (cont.) Because marginal utility diminishes, we would be willing to pay less for the second item than the first. Because marginal utility diminishes, we would be willing to pay less for the second item than the first. We would also be willing to pay even less for the third item We would also be willing to pay even less for the third item Diminishing Marginal Utility can best be visualized in a downward sloping demand curve. Diminishing Marginal Utility can best be visualized in a downward sloping demand curve.

Section 2 Factors Affecting Demand Market Demand can change when: Market Demand can change when: 1. More consumers enter the market 2. When incomes change 3. When tastes change 4. When expectations change 5. When prices of related goods change A graph of a market demand curve can show these changes A graph of a market demand curve can show these changes

Factors Affecting Demand (cont.) When demand goes down, people are willing to buy fewer items at all possible prices. When demand goes down, people are willing to buy fewer items at all possible prices. The Demand Curve will shift to the left. The Demand Curve will shift to the left. When demand goes up, people are willing to buy more items at all possible prices. When demand goes up, people are willing to buy more items at all possible prices. The Demand Curve will shift to the right. The Demand Curve will shift to the right.

Change In the # of Consumers Demand is related to the number of consumers in the area Demand is related to the number of consumers in the area When more people move into an area, they buy more goods and services from local businesses. When more people move into an area, they buy more goods and services from local businesses. Demand Curve shifts to the right Demand Curve shifts to the right

Change In the # of Consumers (cont.) When many people move away from a region, demands for goods and services in the area decreases. When many people move away from a region, demands for goods and services in the area decreases. The Demand Curve shifts to the left The Demand Curve shifts to the left The number of consumers in an area can change due to changes in The number of consumers in an area can change due to changes in –Birthrates -- death rates –Immigration -- migration

Change in Consumer Income Income changes affect demand Income changes affect demand When economy is healthy, people receive raises or move to better paying jobs/positions When economy is healthy, people receive raises or move to better paying jobs/positions With more income, people are willing to buy more of a product at any particular price With more income, people are willing to buy more of a product at any particular price In hard times, people lose their jobs. With less income, people buy less and demand goes down In hard times, people lose their jobs. With less income, people buy less and demand goes down

Change in Consumer Taste Consumer’s tastes change frequently Consumer’s tastes change frequently When a product is popular, the demand curve shifts to the right When a product is popular, the demand curve shifts to the right When a product becomes outdated and obsolete, the popularity fades and demand decreases shifting the demand curve to the left When a product becomes outdated and obsolete, the popularity fades and demand decreases shifting the demand curve to the left

Change in Consumer Expectations People’s expectations can have an affect on demand People’s expectations can have an affect on demand If people believe hard times are on the way, they will buy less shifting the curve to the left If people believe hard times are on the way, they will buy less shifting the curve to the left If people expect shortages of something, demand increases shifting the curve to the right If people expect shortages of something, demand increases shifting the curve to the right

Price Changes in Goods Competing products are called substitutes because consumers can use one in place of the other Competing products are called substitutes because consumers can use one in place of the other Ex. JIF >>>> Peter Pan Ex. JIF >>>> Peter Pan Coca-Cola >>>> Pepsi Coca-Cola >>>> Pepsi hamburgers >>>> hot dogs hamburgers >>>> hot dogs orange juice >>>> ??? orange juice >>>> ??? A change in the price of one good causes the demand for its substitute to move in the same direction A change in the price of one good causes the demand for its substitute to move in the same direction

Price Changes in Goods (cont.) Compliments are products that are used together. Compliments are products that are used together. Ex. JIF >>>> grape jelly Ex. JIF >>>> grape jelly Captain Crunch >>>> milk Captain Crunch >>>> milk hot dogs >>>> buns hot dogs >>>> buns computers >>>> ??? computers >>>> ??? The demand for one complimentary product moves in the opposite direction as the price of the other. The demand for one complimentary product moves in the opposite direction as the price of the other.

Price Changes in Goods (cont.) Question: Question: If the price of DVD players increased, what would you expect to happen to the demand of DVD movies??? Demand would drop Demand would drop

Demand Elasticity When prices rise, we know that quantity demanded will go down, but we do not know by how much When prices rise, we know that quantity demanded will go down, but we do not know by how much Demand Elasticity is the extent to which a change in price causes a change in the quantity demanded for a product Demand Elasticity is the extent to which a change in price causes a change in the quantity demanded for a product Ex. $1.00 >>>$1.25 is a 25% increase for an ice cream cone but how much will the price change affect the people’s demand for the product Ex. $1.00 >>>$1.25 is a 25% increase for an ice cream cone but how much will the price change affect the people’s demand for the product

Demand Elasticity For some goods and services, demand is elastic. For some goods and services, demand is elastic. Each change in price causes a relatively larger percentage change in quantity demanded Each change in price causes a relatively larger percentage change in quantity demanded When the price of a product changes a little, the quantity demanded changes a lot Price change % < demand change % = elastic Price change % < demand change % = elastic

Demand Elasticity (cont.) Demand for a good or service tends to be elastic if it has an attractive substitute. Demand for a good or service tends to be elastic if it has an attractive substitute. Demand also tends to be elastic if the purchase for the item can be postponed. Demand also tends to be elastic if the purchase for the item can be postponed.

Demand Inelasticity For some goods and services, demand tends to be inelastic For some goods and services, demand tends to be inelastic Price changes have little effect on the quantity demanded Price changes have little effect on the quantity demanded Demand for goods with few or no substitutes tend to be inelastic Demand for goods with few or no substitutes tend to be inelastic Price change % > demand change % = inelastic Price change % > demand change % = inelastic

Demand Elasticity and Inelasticity Question: Question: Suppose the price of electricity went up 25%. As a result, the quantity of electricity demanded dropped by 2%. Would you describe the demand for electricity as elastic or inelastic??? electricity would be inelastic

Section 3 What is Supply? Supply – the various quantities of a good or service that producers are willing to sell at all possible market prices. Supply – the various quantities of a good or service that producers are willing to sell at all possible market prices. Supply can refer to the output of one producer or the output of all producers in the market. Supply can refer to the output of one producer or the output of all producers in the market. Producers offer different quantities of a product depending on the price that buyers are willing to pay Producers offer different quantities of a product depending on the price that buyers are willing to pay

What is Supply? (cont.) Quantity supplied varies according to price, but in the opposite direction Quantity supplied varies according to price, but in the opposite direction As price rises, quantity supplied rises, and quantity demanded falls As price rises, quantity supplied rises, and quantity demanded falls P S D P S D

What is Supply? (cont.) Law of Supply dictates that sellers will normally offer more for sale at higher prices and less at lower prices Law of Supply dictates that sellers will normally offer more for sale at higher prices and less at lower prices Higher prices mean higher profit Higher prices mean higher profit Higher profits are incentive to produce more. Higher profits are incentive to produce more.

Supply Schedule, Supply Curve Supply Schedule – table that shows the quantities producers are willing to supply at various prices Supply Schedule – table that shows the quantities producers are willing to supply at various prices As a graph form it can show the supply curve As a graph form it can show the supply curve The supply curve is opposite to the demand curve in that it normally slopes upward from left to right. The supply curve is opposite to the demand curve in that it normally slopes upward from left to right. This reflects the fact that suppliers are generally willing to offer more product at higher prices, less at lower prices This reflects the fact that suppliers are generally willing to offer more product at higher prices, less at lower prices

Profit Businesses provide goods and services to the public with the hopes of earning a profit – the money left over after a business covers it costs. Businesses provide goods and services to the public with the hopes of earning a profit – the money left over after a business covers it costs. You try to sell at prices high enough to cover your costs with something left over You try to sell at prices high enough to cover your costs with something left over It is the primary goal for business owners in our economy It is the primary goal for business owners in our economy

Profit (cont.) Producers have a few options with what they can do with the profit from their business Producers have a few options with what they can do with the profit from their business 1. Increase wages or hire on more workers 2. Invest back into the business by purchasing new space or equipment 3. Keep it all for themselves

Market Supply Market Supply – total of the supply schedules for all providers of the same good or service Market Supply – total of the supply schedules for all providers of the same good or service Works just like individual supply schedule and curve; just on a larger scale. Works just like individual supply schedule and curve; just on a larger scale. Price has the most influence on quantity supplied Price has the most influence on quantity supplied Ex. Car Washing/labor Ex. Car Washing/labor

Factors Affecting Supply Keep in mind, when the market supply goes down supply curve shifts to the left; when the market supply goes up supply curve shifts to the right. Keep in mind, when the market supply goes down supply curve shifts to the left; when the market supply goes up supply curve shifts to the right. Why would supply change in the whole market? Why would supply change in the whole market? 8 factors or reasons that would affect supply. 8 factors or reasons that would affect supply.

Factors Affecting Supply (cont.) 1. Changes in the Cost of Resources When prices for resources fall, cost of production falls; producers willing to offer more at all prices 2. Productivity Efficiency is more output in same amount of time; reduces production costs; more products at every price 3. Technology Refers to methods or processes used to make goods or services; new technology can speed up production thus cutting costs

Factors Affecting Supply (cont.) 4. Change in government policy Tighter vs. relaxed government regulations can affect costs of production 5. Change in Taxes and Subsidies Subsidy—gov’t payment to an individual or business for certain actions; encourage producers to enter or even stay in the market; taxes and subsidies change production costs 6. Producer Expectations Predictions on what demand might look like in the near future

Factors Affecting Supply (cont.) 7. Number of Suppliers As more firms enter an industry, supply increases; suppliers leave, market supply decreases

Elasticity of Supply Supply Elasticity– measures how quantity supplied of a good/service changes in response to a change in price Supply Elasticity– measures how quantity supplied of a good/service changes in response to a change in price QS changes a lot compared to price =supply elastic QS changes a lot compared to price =supply elastic QS changes little compared to price =supply inelastic QS changes little compared to price =supply inelastic

Elasticity of Supply (cont.) Products that cannot be made quickly or are expensive to produce tend to be inelastic Products that cannot be made quickly or are expensive to produce tend to be inelastic Products that can be made quickly without large investments of money or skilled labor tend to be supply elastic Products that can be made quickly without large investments of money or skilled labor tend to be supply elastic

Section 4 Markets and Prices Forces of supply and demand work together in markets to establish prices. Forces of supply and demand work together in markets to establish prices. Prices form the basis of economic decision Prices form the basis of economic decision Surplus – QS is higher than QD Surplus – QS is higher than QD signals that the price is too high; consumers will not buy all of the product suppliers are willing to sell Will not last long, price will be lowered to move product Will not last long, price will be lowered to move product

Markets and Prices (cont.) Shortage – QD is higher than QS Shortage – QD is higher than QS signals that the price is too low; suppliers will not supply all of the product that consumers are willing to buy. Will not last long, sellers will raise their price Will not last long, sellers will raise their price If left to itself, economy will fix itself. If left to itself, economy will fix itself. Surplus forces price down; Shortage forces price up until balance is achieved Surplus forces price down; Shortage forces price up until balance is achieved

Markets and Prices (cont.) Equilibrium Price – point at which supply and demand are balanced; neither surplus or shortage exist Equilibrium Price – point at which supply and demand are balanced; neither surplus or shortage exist Temporary changes may occur (Hurricane Katrina or Gustov) but the market will adjust to reach a new equilibrium price Temporary changes may occur (Hurricane Katrina or Gustov) but the market will adjust to reach a new equilibrium price

Price Controls Price Ceiling – Gov’t set maximum price that can be charged for a good or service Price Ceiling – Gov’t set maximum price that can be charged for a good or service Price Floor -- Gov’t set minimum price that can be charged for a good or service Price Floor -- Gov’t set minimum price that can be charged for a good or service

Price as Signals Prices are signals that help businesses and consumers make decisions Prices are signals that help businesses and consumers make decisions Prices help businesses and consumers answer the 3 basic economic questions: Prices help businesses and consumers answer the 3 basic economic questions: WHAT TO PRODUCE HOW TO PRODUCE FOR WHOM TO PRODUCE

Advantages of Prices 1. Prices are Neutral favor neither producer or consumer; merely a compromise between the two 2. Prices are Flexible both react to unforeseen events by adjusting production and consumption based on the new prices

Advantages of Prices (cont.) Prices and Freedom of Choice Prices and Freedom of Choice Pricing system and market economy provides consumers a variety of products and prices to choose from unlike command economies Prices are Familiar Prices are Familiar This allows us to make buys quickly and efficiently; no misunderstanding, we know through prices the value of particular products